What’s Going on in the Markets May 8, 2022

It was another down week in the stock markets, which, under the surface, was worse than the Dow Jones Industrial Average and S&P 500 indexes being down only about 0.25% might have suggested. Volatility continues to rule the markets daily as investors and traders try to discount the effects of inflation, interest rate hikes, a raging war, and the possibility of a recession in the coming months.

Speaking of interest rate hikes, the Federal Reserve (The Fed) met last week and raised short-term interest rates by 0.5% (bringing them to 0.75%-1.00%). The Fed signaled that more 0.5% interest hikes were likely coming and also mentioned that single day 0.75% hikes were not being considered. Although the markets breathed a sigh of relief on Wednesday and rallied about 3% from the day’s lows, that rally was short-lived as the markets gave it all back and more on Thursday and Friday.

As of Friday’s close, the S&P 500 index is down about 13.5%, while the harder-hit tech-heavy NASDAQ is down about 22.3% year-to-date. Those figures, however, don’t reflect the level of carnage under the surface, where some growth stocks are down as much as 80% from their prior peaks. Strength in the markets is found in energy stocks (where oil prices continue to float above $100 a barrel) and defensive stocks (consumer staples, some healthcare, and utilities).

Even bonds, long known to provide ballast to stocks, are down about 11% year-to-date and have not held up their end of the bargain. Bonds are having one of their worst starts to the year since the 1970s. Even if you’re hiding out in 1–3 year short-term treasury bonds, you’re still down about 3.1% since the beginning of the year. The typical 60/40 (stock/bond) portfolio has provided no shelter from the recent market storm.

When you see both stocks and bonds down in tandem, the usual culprit is an inflationary environment. Last month’s government report on inflation, the Consumer Price Index (CPI), showed inflation rose 1.2% in March, translating to an annualized rate of 8.5%. This coming Wednesday, we get the read on April inflation, which should see inflation easing from March levels (based on reports of declining used car prices, lower demand for homes, and supply chain improvements).

The Fed has two core mandates as its mission: 1) keep unemployment low and 2) maintain price stability.

At this point, The Fed has no choice but to raise interest rates to try and tame the inflation beast. Unfortunately, raising short-term interest rates has the side effect of slowing economic activity because capital becomes more expensive for both consumers and companies, thereby forcing a slowdown of discretionary purchases and capital improvements (and stock buybacks, which buoy the markets). We are already seeing a slight easing in housing market pressures as 30-year mortgage rates tick above 5%.

Inflation at the current rates is simply not tenable, and therefore The Fed must do what it can to keep the prices of goods and services at prices that consumers can afford.

Further taming of the inflation beast with short-term interest rate hikes can sometimes cause such a slowdown in the economy that we see negative growth in the gross domestic product (GDP), as was reported in the 1st quarter of 2022 when GDP unexpectedly contracted by 0.4% (which is an annualized rate of 1.4%).

As of the end of the 1st quarter, we had only experienced a single 0.25% short-term interest rate hike by The Fed, so that was not the proximate cause of the decline in GDP. More likely, the side effects of the ongoing war in Ukraine, a complete lockdown in parts of China because of COVID resurgence, and inflation worries all weighed on the economy in an otherwise environment of robust consumer demand.

The definition of an economic recession is two consecutive quarters of contracting GDP, so 2nd quarter 2022 GDP is pivotal in determining whether we’re already in an economic recession. Perhaps that’s what has the markets worried.

Also on the economic front, both the Institute for Supply Management’s (ISM) Manufacturing Index and the ISM Services Index remained at high levels last month; however, there is some weakness developing under the surface. The ISM Manufacturing Index has fallen in five of the last six months, while new orders for the services sector fell to a 14-month low. At the same time, prices have remained stubbornly high in both indexes, which raises the possibility of economic stagflation (inflation + slowing economy) in the coming months.

What About Now?

While the markets continue their correction (pullback), we have continued to get more defensive in our client portfolios by selling more (underperforming) positions, adding to our hedges, and tightening up our option selling. Unfortunately, in a rising volatility environment, the fruits of our option selling labor don’t begin to show up in client portfolio results until after the volatility subsides, or those sold options expire. That doesn’t mean we won’t continue to allocate to those strategies to reduce portfolio risk, but in the short term, they may not display the intended positive portfolio effects.

While I don’t have a working crystal ball, I’ve seen little evidence that the volatility is about to subside anytime soon. Though the markets are oversold (stretched to the downside) on a short-term basis, we have not seen any bounces that have lasted longer than a day or two, at least not since late March. We are certainly overdue for a robust bounce that lasts at least a few weeks or months, but I don’t see any evidence to believe that we’re at a durable long-term bottom yet.

Therefore, this back-and-forth choppy action may continue until after the mid-term elections, as is typical for this part of the presidential cycle. We may also need to shake out more weak hands in the short term and get to some level of capitulation or panic in order to get a sustainable rally.

One contrary indicator, investor sentiment about the markets, is at some of the lowest levels–some levels on par with sentiment during the great financial crisis in 2007-2009 and the COVID crisis, hinting that investors are not very exuberant about investing in the markets. Another contrary indicator, mutual fund flows, shows that investors of late are cashing out of stocks in recent weeks, which means at some point, many will be forced to buy back their stocks in the near future.

If you’re not a client of ours, I hope you have taken some action with your portfolio during the prior market rallies, to reduce your overall risk and exposure to the stock market. Whether selling some underperforming positions, buying some bear market funds, or just hedging your portfolio in one way or another, figure out a way to reduce your overall portfolio risk. Don’t wait until the market is down a lot before taking some action. You want to have some cash on hand to pick up some “bargains” once the market resumes its uptrend.

If you have not, or if you still feel overexposed, you should consider doing so during the next market rally to bring your portfolio more in line with your own personal risk tolerance. This is especially true if you find yourself worried about your investments more than usual these days. Remember, no one can control what the market does, but you and only you can control the risk you’re taking and the amount of the loss you wish to sustain. If you’re picking up anything on this downturn, keep it small and expect that you’ll have to wait some time to become profitable on these positions. Disclaimer: None of the foregoing should be construed as investment advice or a recommendation to buy or sell any security. Please consult with your own financial advisor or talk to us if you need help.

In a rising interest rate environment where inflation is not yet under control, and where The Fed is now a net seller of bond assets (instead of a buyer), stocks will have a hard time making it back to old highs, not to mention making new ones. While the 13-year-old bull market may not be finally dead, I don’t see this environment as friendly to investing as it has been in the recent past. Don’t assume that the “beach-ball” market that absorbed all manner of “meme stocks”, special purpose acquisition companies (SPACs), Ponzi stocks, a flood of IPOs, and additional stock offerings is going to come roaring back, because I don’t believe that it will anytime soon. Remember, if your favorite stock is down 50%, you need it to double just to get back to even. I don’t think you can count on that anytime soon either.

There’s a saying in the investing world that most have heard: “Don’t Fight The Fed.” That means when The Fed is accommodative with low-interest rates and is actively providing liquidity to the markets (as they mostly have for the past 13 years), you’re essentially investing with the wind at your back. In that environment, you want to be a net buyer, not a net seller of securities.

If you believe that saying is true during the accommodative periods, then trying to fight the Fed when they are withdrawing liquidity and raising interest rates and insisting that the market should go up in the face of those headwinds would not make much sense during the non-accommodative period we’re experiencing right now.  A time of Fed accommodation will return at some point but be patient and cautious with new investments until then.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Minimum Distribution, Maximum Confusion

Summary: The RMD 10-year rule substantially reduces the ability of most non-spouse beneficiaries to stretch distributions from an inherited defined contribution plan or IRA after the death of the original owner.

The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 changed the rules for taking distributions from retirement accounts inherited after 2019. The new so-called “10-year rule” generally requires inherited accounts to be emptied within 10 years of the original owner’s death, with some exceptions. When no exception applies, the entire account must be emptied within 10 years of the beneficiary’s death, or within 10 years after a minor child, beneficiary reaches age 21. This reduces the ability of most beneficiaries to spread out, or “stretch,” distributions from an inherited defined contribution plan or an IRA.

In February 2022, the IRS issued proposed regulations (generally applicable starting in 2022) that interpret the revised required minimum distribution (RMD) rules. Unless these proposals are amended, some beneficiaries could be subject to annual required distributions as well as a full distribution at the end of a 10-year period. Account owners and their beneficiaries may want to familiarize themselves with these new interpretations and how they might be affected by them.

RMD Basics

If you own a traditional IRA or participate in a retirement plan like a 401(k), you generally must start taking RMDs for the year you reach age 72 (age 70½ if you were born before July 1, 1949). If you’re age 72 or older and still working for the employer that maintains the retirement plan, you may be able to wait until the year after retiring to start RMDs from that account. No RMDs are required from a Roth IRA during your lifetime (beneficiaries are subject to inherited retirement account rules). Failing to take an RMD can be costly: a 50% penalty generally applies to the extent an RMD is not made.

The beginning date for the first year you are required to take a lifetime distribution is no later than April 1 of the next year. After your first distribution, annual distributions must be taken by the end of each year. (Note that if you wait until April 1 to take your first-year distribution, you would have to take two distributions for that year: one by April 1 and the other by December 31. This has the potential to spike your tax rate, so discuss this with your financial or tax planner before deciding to defer your first RMD.)

When you die, the RMD rules also govern how quickly your retirement plan or IRA will need to be distributed to your beneficiaries. The rules are largely based on two factors: (1) the individuals you select as beneficiaries of your retirement plan, and (2) whether you pass away before or on or after your required beginning date (RBD). Because no lifetime RMDs are required from a Roth IRA, Roth IRA owners are always treated as dying before their required beginning date.

Who Is Subject to the 10-Year Rule?

The SECURE Act does still allow certain beneficiaries to continue to “stretch” distributions, at least to some extent. These eligible designated beneficiaries (EDBs) include your surviving spouse, your minor children, any individual not more than 10 years younger than you, and certain disabled or chronically ill individuals. Generally, EDBs are able to take annual required distributions based on their remaining life expectancy. However, once an EDB dies, or once a minor child EDB reaches age 21, any remaining funds must be distributed within 10 years.

Most importantly, though, the SECURE Act requires that if your designated beneficiary is not an EDB, the entire account must be fully distributed within 10 years after your death.

What If Your Designated Beneficiary Is Not an EDB?

If you die before your required beginning date, no distributions are required during the first nine years after your death, but the entire account must be distributed in the tenth year.

If, however, you die on or after your required beginning date, the newly issued regulations clarified that annual distributions based on the designated beneficiary’s remaining life expectancy are required in the first nine years after the year of your death, then the remainder of the account must be distributed in the tenth year.

What If Your Beneficiary Is a Nonspouse EDB?

Here’s where it can get more complicated. After your death, annual distributions will be required based on remaining life expectancy. If you die before your required beginning date, required annual distributions will be based on the EDB’s remaining life expectancy. If you die on or after your required beginning date, annual distributions after your death will be based on the greater of (a) what would have been your remaining life expectancy or (b) the beneficiary’s remaining life expectancy. Also, if distributions are calculated each year based on what would have been your remaining life expectancy, the entire account must be distributed by the end of the calendar year in which the beneficiary’s remaining life expectancy would have been reduced to one or less (if the beneficiary’s remaining life expectancy had been used).

After your beneficiary dies, or your beneficiary who is your minor child turns age 21, annual distributions based on remaining life expectancy must continue during the first nine years after the year of such an event. The entire account must be fully distributed in the tenth year.

What If Your Designated Beneficiary Is Your Spouse?

There are many special rules if your spouse is your designated beneficiary. The 10-year rule generally has no effect until after the death of your spouse, or possibly until after the death of your spouse’s designated beneficiary.

What Life Expectancy Is Used to Determine RMDs After You Die?

Annual required distributions based on life expectancy are generally calculated each year by dividing the account balance as of December 31 of the previous year by the applicable denominator for the current year (but the RMD will never exceed the entire account balance on the date of the distribution).

When your life expectancy is used, the applicable denominator is your life expectancy in the calendar year of your death, reduced by one for each subsequent year.  When the non-spouse beneficiary’s life expectancy is used, the applicable denominator is that beneficiary’s life expectancy in the year following the calendar year of your death, reduced by one for each subsequent year. (Note that if the applicable denominator is reduced to zero in any year using this “subtract one” method, the entire account would need to be distributed.) And at the end of the appropriate 10-year period, any remaining balance must be distributed.

The rules relating to required minimum distributions are complicated, and the consequences of making a mistake can be severe. Talk to us to understand how the rules, and the new proposed regulations, apply to your individual situation.

If you would like to review your current investment portfolio or discuss your RMDs, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Common Tax Scams to Beware Of

According to the Internal Revenue Service (IRS), tax scams tend to increase during tax season and times of crisis. Now that tax season is in full swing,  the IRS is reminding taxpayers to use caution and avoid becoming the victim of a fraudulent tax scheme.   Here are some of the most common tax scams to watch out for.

Phishing and text message scams

Phishing and text message scams usually involve unsolicited emails or text messages that seem to come from legitimate IRS sites to convince you to provide personal or financial information. Once scam artists obtain this information, they use it to commit identity or financial theft. The IRS does not initiate contact with taxpayers by email, text message, or any social media platform to request personal or financial information. The IRS initiates most contacts through regular mail delivered by the United States Postal Service.

Phone scams

Phone scams typically involve a phone call from someone claiming that you owe money to the IRS or you’re entitled to a large refund. The calls may show up as coming from the IRS on your Caller ID, be accompanied by fake emails that appear to be from the IRS, or involve follow-up calls from individuals saying they are from law enforcement. These scams often target more vulnerable populations, such as immigrants and senior citizens, and use scare tactics such as threatening arrest, license revocation, or deportation.

Tax-related identity theft

Tax-related identity theft occurs when someone uses your Social Security number to claim a fraudulent tax refund.  You may not even realize you’ve been the victim of identity theft until you file your tax return and discover that a return has already been filed using your Social Security number.  Or the IRS may send you a letter indicating it has identified a suspicious return using your Social Security number.  To help prevent tax-related identity theft, the IRS now offers the Identity Protection PIN Opt-In Program.  The Identity Protection PIN is a six-digit code that is known only to you and the IRS, and it helps the IRS verify your identity when you file your tax return.

Tax preparer fraud

Scam artists will sometimes pose as legitimate tax preparers and try to take advantage of unsuspecting taxpayers by committing refund fraud or identity theft. Be wary of any tax preparer who won’t sign your tax return (sometimes referred to as a “ghost preparer”), requires a cash-only payment, claims fake deductions/tax credits, directs refunds into his or her own account or promises an unreasonably large or inflated refund. A legitimate tax preparer will generally ask for proof of your income and eligibility for credits and deductions, sign the return as the preparer, enter a valid preparer tax identification number, and provide you with a copy of your return.   It’s important to choose a tax preparer carefully because you are legally responsible for what’s on your return, even if it’s prepared by someone else.

False offer in compromise

An offer in compromise (OIC) is an agreement between a taxpayer and the IRS that can help the taxpayer settle tax debt for less than the full amount that is owed. Unfortunately, some companies charge excessive fees and falsely advertise that they can help taxpayers obtain larger OIC settlements with the IRS.  Taxpayers can contact the IRS directly or use the IRS Offer in Compromise Pre-Qualifier tool to see if they qualify for an OIC.

Unemployment insurance fraud

Typically, this scheme is perpetrated by scam artists who try to use your personal information to claim unemployment benefits. If you receive an unexpected prepaid card for unemployment benefits, see an unexpected deposit from your state in your bank account, or receive IRS Form 1099-G for unemployment compensation that you did not apply for, report it to your state unemployment insurance office as soon as possible.

Fake charities

Charity scammers pose as legitimate charitable organizations in order to solicit donations from unsuspecting donors. These scam artists often take advantage of ongoing tragedies and/or disasters, such as a devastating tornado, war or the COVID-19 pandemic. Be wary of charities with names that are similar to more familiar or nationally known organizations. Before donating to a charity, make sure it is legitimate, and never donate cash, gift cards, or funds by wire transfer.  The IRS website has a tool to assist you in checking out the status of a charitable organization.

Protecting yourself from scams

Fortunately, there are some things you can do to help protect yourself from scams, including those that target taxpayers:

  • Don’t click on suspicious or unfamiliar links in emails, text messages, or instant messaging services — visit government websites directly for important information
  • Don’t answer a phone call if you don’t recognize the phone number — instead, let it go to voicemail and check later to verify the caller
  • Never download or open email attachments unless you can verify that the sender is legitimate
  • Keep device and security software up-to-date, maintain strong passwords, and use multi-factor authentication
  • Never share personal or financial information via email, text message, or over the phone

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

What’s Going on in the Markets February 27, 2022

Since our last post on What’s Going on in the Markets on January 30, 2022, the market has seen a flurry of volatility trying to come to grips with higher than expected inflation, the Russian invasion of Ukraine, and the coming interest rate increases by the Federal Reserve. Our hearts go out to those suffering in Ukraine because of yet another unnecessary war.

Since the beginning of the year, while the S&P 500 Index has seen a maximum decline of approximately 11% on a daily closing basis, the carnage under the surface in many stocks and sectors of the markets has been far worse with some stocks down more than 75% on the year. In this post, we’ll look at the factors that may call for further declines or for a coming rally.

The Good

We’ve previously written about how markets undergo a pullback greater than 10% on average every 10-12 months, also called a correction. Therefore, the current correction, which was long overdue by the time it arrived in January, is part of the normal course of ebbs and flows in the stock markets. No one really knows if a correction will devolve into a full-blown bear market until after the fact (a bear market is a decline of 20% or more from the last market peak). While bear markets tend to be harbingers of coming recessions, they don’t always forecast them with 100% accuracy (nothing does).

Historically speaking there are no bells rung at the start of a bear market. In fact, market tops are notoriously difficult to identify except in hindsight, as they are often quite volatile and take months to unfold. The good news is that we’ve been preemptively defensive in our portfolio decisions. The bad news is that a few bear market warning flags are starting to sequentially wave and resemble some of the ones we’ve seen in the most significant bull market tops in history. But it’s not yet a sign to sell everything.

Corporate earnings are the primary driver of the stock market. Simply put, the better the earnings, the higher the market can go. Towards that end, the corporate earnings reports for the 4th quarter of 2021 were better than expected from a revenue and net income perspective, and corporate guidance (forecasting) relating to 1st quarter 2022 earnings were equally positive. Earnings guidance for the rest of 2022 tended to be even more positive and points to a reacceleration of the economy in the back half of the year. That tends to indicate that a recession is off the table, which is consistent with my beliefs and would stave off a bear market.

From a COVID-19 standpoint, since we’ve tamed the Omicron variant, the country is starting to plan for a return to a bit of normalcy with the relaxing of masking requirements around the country and less onerous vaccination mandates. This alone ought to put a bid into the travel, entertainment and leisure industry, as pent-up demand picks up steam and drives further spending. This also adds to the “no recession on the horizon” narrative.

The joblessness and employment figures are surprisingly to the good side, with unemployment levels lower and jobs numbers steadily improving. And employees and new hires are seeing higher wages, which again, will drive higher spending that will stave off a recession (but unfortunately, also drive inflation higher).

While the effects of the Russian invasion of Ukraine may have some impact on the delivery timeline of various goods and services, the supply chain constraints that plagued the economy in 2021 seem to be subsiding, removing some inflationary pressure, and allowing more deliveries of materials and finished goods to factories and consumers respectively.

The Bad

With one trading day left in the month, the S&P 500 Index is down about 3% for the month and down 8% from the year-end 2021 close. While totally within the realm of normal expected volatility, especially for a mid-cycle election year, it’s never fun to experience that kind of decline. That’s because, as mentioned above, many sectors and stocks have been hit far harder. Fortunately, the last couple of days saw a robust bounce in the markets from the depths of fear at the start of the invasion of Ukraine.

Inflation continues its domination of headlines as the last consumer price index clocked in at an annualized rate of 7.5% for January. Energy prices continue to rage higher as we saw oil a touch above $100 a barrel overnight last Thursday as news of the Ukraine invasion started to hit the headlines (the price of oil settled slightly under $92 at Friday’s close, but is spiking again in the Sunday overnight futures market). Food and commodity prices don’t seem to have found a ceiling yet. While some easing of inflationary pressures is expected as supply chains get back to normal and as jobs get filled, it won’t be enough to stave off interest rate hikes by the federal reserve, which are needed to keep inflation in check. I believe that we may have seen the worst of the inflation fears in January.

Speaking of interest rate hikes, estimates vary widely as to how many hikes the federal reserve will have to implement to tame the inflation beast (economists estimate between three and nine 0.25% hikes in 2021 alone). Even if we get eight 0.25% hikes this year, which I consider unlikely, we’ll still be at a 2% federal funds rate, which is quite accommodative for the economy and is generally still quite favorable for the stock market. Unfortunately, higher interest rates have a negative impact on bond prices, which have not yet found a footing this year either (but haven’t collapsed either).

Investor sentiment/psychology (feelings about the stock market) and consumer confidence are somewhat worrisome as they continue to remain moribund in the face of an economy that’s firing on all cylinders and a job seekers’ market that puts them somewhat in control (versus employers) and favors continued robust spending. Highly confident consumers tend to spend more, which drives the economy.

There is convincing evidence today that housing prices are in bubble territory. This carries strong implications for financial markets and the economy given the importance of housing to consumers’ views of their personal balance sheets. Unlike the 2005 Housing Bubble, which was largely predicated on subprime lending and credit default risk, today’s bubble has far more to do with affordability and interest rate risk. Mortgage rates have been suppressed over the past decade by the Federal Reserve’s ultra-accommodative monetary policies, including direct purchases of trillions of dollars in mortgage-backed securities and near-zero interest rates.

Mortgage rates dropped to a record low of 2.7% in early 2021 after the Fed threw the proverbial kitchen sink at the economy in response to the pandemic. However, the recent rise in long-term interest rates, along with the Federal Reserve’s decision to taper their asset purchases, have caused mortgage rates to spike back to 3.7% – the highest level in nearly two years. The combination of rising rates and rising prices has made the average mortgage payment on the same property approximately 30% more expensive than just a year ago. Monitoring the state of the housing market will be crucial in the months ahead as the Federal Reserve is due to begin tightening monetary policy as discussed above.

The Ugly

The Russian invasion of Ukraine is without a doubt an ugly, if not a well telegraphed development. If there was a wild card for the world economic recovery from the pandemic, it’s this–which has the possibility of derailing the recovery by disrupting supply chains and the flow of essential commodities from the region. Economic sanctions unfortunately tend to affect citizens more than the leaders they target, and also have an indirect adverse effect on the countries imposing them. Wars are of course unpredictable, so predicting the outcomes or effects is crystal ball type of speculation.

As the war stakes are raised, so too are the risks to the markets. If calmer heads prevail and escalation to the unthinkable can be avoided, then this should be another one of those bricks in the proverbial walls of worry of the stock markets. A protracted war that draws in other countries will lead to a market that no doubt will sell first and asks questions later.

However, one important historical insight is that most geopolitical crises or regional conflicts do not have a negative long-term impact on the stock market. In the few instances where geopolitical events have weighed on the market, it has been a result of either a broad-based global military conflict or a rise in energy prices (inflation) that puts upward pressure on U.S. interest rates (monetary policy). Of the last eleven crises/conflicts leading to war, only four of them led to a decline of 20% or more in the S&P 500 Index.

The current Russia-Ukraine conflict is likely to cause even higher energy prices, yet at the same time, might reduce the possibility of a full 0.50% rate hike from a concerned Federal Reserve in March.

The biggest concern from fighting a protracted war is a possible global slowdown, which forces us into a recession. Should that happen, I imagine it will be mitigated by a slowing of interest rate hikes and perhaps monetary stimulus. I consider this scenario unlikely at this time.

Now What?

We continue to expect volatility during this mid-term election year and remain cautious and defensive in our positioning. A deeply oversold market resulted in a big bounce on Thursday and Friday of last week, but the escalation in the rhetoric, a worsening of war tactics and increasing economic sanctions over the weekend are likely to trump any oversold markets, and we could see a big give-back of the gains of the last two days come Monday, the last trading day of February. The futures markets on Sunday night portend a very weak open for Monday morning.

There is no doubt that there is a higher-than-normal degree of risk in the market today, and there has already been a significant amount of damage under the surface.  While the S&P 500 Index is currently only 8% off its January high, virtually half of all S&P 500 stocks (and an estimated 80% of NASDAQ stocks) are already down over 20% from their highs.

The jury is out on whether this will be a protracted correction or a major bear market. However, we know that every bear market started out as a pullback, some pullbacks led to a correction, some corrections led to a small bear market, and every big bear market started out as a small bear market. And that makes the next 60-90 days perhaps the most critical in this market cycle stretching back to its start in 2009 (excluding the COVID-19 crash).

Like everything else in life, there is no crystal ball when it comes to navigating the eventual end of a market cycle. Rather, a disciplined assessment of the weight of the evidence allows us to proactively position client portfolios to be defensive when it really matters. Going forward, we are prepared to further increase portfolio defenses depending on how the events in the market unfold. Using options, inverse funds, reducing under-performing positions and harvesting profits are all ways we can reduce client portfolio risk without necessarily exiting the markets (Disclaimer: none of this is a recommendation to buy or sell any securities).

“In the end, navigating a [probable] bear market is not about putting your money under a mattress and waiting for the sky to fall. Instead, the focus should be on proactively managing risk to carefully navigate a wide range of outcomes and positioning oneself for that next great buying opportunity.”-James Stack, InvesTech Research

No doubt these can be scary times for your hard-earned nest egg, and no one enjoys giving back a chunk of market gains. But as we’ve said before, the best way to profit from the stock market is to not get scared out of it. Enduring volatility is the price we pay for the outsized gains we get from investing in the stock market, but if you find yourself losing sleep over your portfolio, talk to your financial adviser (or contact us) so you’re invested in a portfolio that has the right amount of risk for your personal temperament.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Source: InvesTech Research

What’s Going on in the Markets January 30, 2022

With only one trading day left in the month, this January has seen the worst start to the year in the stock markets since 2008. Down just a tad under 10% year-to-date, after a stellar and steady 2021, could the auspicious start in the S&P 500 index portend a poor 2022 for the markets? After all, a popular market aphorism is “as January goes, so goes the rest of the year”.  Anyone who knows me well knows that I don’t ascribe much value to these popular sayings.

Much of the recent market volatility can be attributed to: 1) angst over COVID-19 variants; 2) worries about a federal reserve that has all but telegraphed 2-4 interest rate hikes in 2022; 3) the suspension of monetary stimulus (to combat inflation); 4) the absence of any significant fiscal stimulus expected from Washington; and 5) concerns over a potential Russian incursion into the Ukraine.

In this write-up, I’ll try to explain my viewpoint of what is going on in the economy and markets, and whether I think we’re heading for a much deeper pullback in the markets, or perhaps an economic recession.

Pullbacks, Corrections and Bear Markets

Enduring volatile markets is the price we pay for outsized returns that we ultimately earn for risking our money in the stock markets. Why even bother? Because cash and savings accounts pay us nothing, and bonds, which on average yield low single digit annual returns, ultimately lost a little money in 2021. Simply put, we need an alternative to stashing our money under the mattress. That’s especially true at a time when inflation is finally rearing its ugly head in a higher-than-expected way.

We need to invest in a way to at least overcome the depreciating effects of inflation on the buying power of our cash. Of course, we also need to be adequately compensated for taking the risk of investing in the stock markets.

In the media, you’ll hear about pullbacks, which is essentially any decline in prices of less than 10% from the last peak in the index, fund, or stock. Next, you’ll hear about a correction, which is a decline of 10%-19% in prices from the last peak. Finally, a bear market is a decline of 20% or more from the last peak.

2021 was such a smooth and steady uptrending year, where we barely had a couple of 5% pullbacks. By comparison, we generally experience between one and three 5% pullbacks a year. 2021 had no corrections, although we generally get one every 10-12 months. The last bear market we experienced came in February-March 2020 in the form of a 35% decline from peak to trough in the S&P 500 index, attributable to fears over COVID-19. We generally see a bear market every 3-7 years on average.

It seems obvious and unnecessary to state that the stock market is truly a “market of stocks”. Then why even say it? Because to understand what leads to pullbacks, corrections, and bear markets, you must drill down into the details of the indexes and see what’s really happening with individual stocks.

Despite an obvious uptrend in the indexes in 2021, digging into the details, you could see that there was trouble brewing under the surface. The number of uptrending stocks (stocks going higher) peaked in February 2021. So did the number of stocks making new 52-week (one-year) highs. At the same time, the number of stocks making 52-week lows bottomed and turned upward. A truly healthy market does the opposite of all this. But in fairness, after a very strong finish to 2020, the market was overdue in 2021 to take a “rest”.

In stock market parlance, we call the number of uptrending stocks relative to downtrending stocks, and the ratio of stocks making 52-week highs relative to those making 52-week lows, components of “market breadth”.

For most of 2021, despite the stock market indexes making new highs on a regular basis, it was doing so with fewer and fewer stocks participating. An estimated 10%-15% of all stocks, which were quite strong, were masking weakness in the other 85%-90% of stocks. Small capitalization stocks, which make up the largest sub-segment of the stock market (in terms of number of stocks, not company size), peaked in March 2021 (note that small stocks attempted and failed in a rally attempt in November 2021).

All throughout 2021, we also observed more and more stocks making 52-week lows, and fewer and fewer making 52-week highs. Many stocks were down 20%-70% or more from their peaks, and those new low counts were increasing almost daily. Some COVID related and stay-at-home stocks which were the heroes of 2020 were being smashed. How can that be? After all, we were still making new market index highs on a regular basis throughout the year.

Without going into a long-detailed explanation about the structure of market indexes, let’s just say that the biggest companies such as Apple and Microsoft (called large or mega capitalization stocks) have the biggest effects on the indexes, even if they are smallest in number. That’s how a cohort of 20-25 stocks could fool you into thinking that all was going great in the markets. Dig deeper–and you saw healthcare, industrial and communications stocks deteriorate as the year wore on.

If you wondered why your diversified portfolio didn’t return anywhere near the returns on the indexes, the above partially explains it. If you didn’t own enough of the chosen few outperforming stocks, your portfolio no doubt underperformed the market averages. That’s called stock investing for the long term, and it’s typical of many periods in the stock markets.

You’ll rarely if ever hear about the deterioration of market breadth on the evening news; you’ll only hear about new record highs in the indexes. Now you know a little better.

Pluses and Minuses

What does this mean for the market going forward? Are we headed for an economic recession? A bear market? Another double-digit return year? I’ll first discuss the pluses and minuses and then tell you what I see when I consult my broken crystal ball for the rest of the year.

Pluses

  1. The economy is quite strong and continues to exhibit growth, with estimates of 3%-4% gross domestic product growth expected for 2022. Before COVID-19, our economy was growing at an annual rate of 2%-3%, but due to unprecedented stimulus, we have temporarily skewed the economic picture. I would expect the economy to return to normal levels of growth in 2023.
  2. The job market continues to be robust and “tight”. Many more jobs are going unfilled than at any time in recent history, and that portends good starting wages for those looking for work. Companies that are expecting a recession would not be increasing posts for new and unfilled positions as they are right now. Higher wages mean that employees have more money to spend on goods and services, keeping upward pressure on the economy.
  3. Earnings estimates for companies, which are the primary driver of stock market returns, continue to impress and increase over 2021 levels. Consumers are still spending strongly.
  4. Many experts believe that the Omicron variant of COVID is the “swan song” of the disease, and that by mid-2022, the pandemic will be just another virus that is a part of our daily lives.
  5. Traffic, travel, hospitality as well as office occupancy are slowly showing signs of returning to pre-pandemic levels in many major cities around the world.
  6. Supply chain disruptions are easing around the world, taking inflationary pressures down with them.
  7. Used car prices, a leading contributor to inflation, could be easing as semi-conductor chip production ramps up and finds its way into automakers’ cars waiting for delivery on their lots.
  8. Consumer spending and demand for goods and services continues to be robust. Demand for travel and leisure services, considering the potential fading of COVID, can only be expected to increase.
  9. The recent market sell-off has shaved off some speculative fervor from the markets, and the market is oversold on many metrics, which portends at least a short-term bounce (which may have started on Friday, January 28th).

Minuses

  1. The strength in the economy could be hurt in the 1st quarter of 2022 due to the Omicron variant disrupting production, increasing absenteeism, and reducing employee productivity.
  2. Job growth and employee shortages contribute to wage inflation, which is the leading contributor to overall inflation. This will continue to pressure the federal reserve to increase interest rates to cool the economy. Higher interest rates reduce corporate earnings via higher interest expense, and implicitly lead to reduced stock price multiples (price-earnings ratio).
  3. Although the recent sell-off has somewhat cooled the speculative fever in the stock markets, initial public offerings, special purpose acquisition companies, cryptocurrencies and non-fungible tokens, relative excess enthusiasm around speculation remains.
  4. Housing prices may be in a bubble. With a continued short supply of available housing, this could also continue to exert upward pressure on housing prices for some time to come.
  5. Monetary and fiscal stimulus, the prominent catalysts in one of the quickest recoveries from one of the shortest recessions in history (2020), looks to be notably absent given Congress’ failure to pass the Build Back Better stimulus bill last year. The likelihood of passing significant alternate stimulus legislation in a mid-term election year seems unlikely.

My Broken Crystal Ball Expectations

Normally, I try and avoid speculation about the future of the markets and economy, because I’ll just be guessing like anyone else.  But given that I manage million-dollar portfolios, and that I must make educated guesses about stocks, the markets, and the economy every day, I provide my thoughts for what they’re worth.

The weight of evidence points to a continuation of robust economic conditions that will lead to higher corporate profits. In other words, I don’t believe that 2022 will be the year we experience an economic recession.

This should lead to a stock market that’s higher at year-end than it is today. How much higher, if I had to guess, is probably less than 10%-12% from where we are today. That would mean we probably won’t make new highs in the markets for the rest of the year, which obviously means that I don’t think we’ll have a bear market this year.

Given uncertainty and angst over federal reserve short-term interest rate hikes and the ultimate lingering effects of COVID, I have near conviction that the volatility in the markets for 2022 will persist. That’s not saying much if I’m honest, because volatility is always expected in the markets. What I really mean is that the relative calm of 2021 won’t be repeated in 2022. But with volatility come opportunities to make new investments in stocks that become somewhat more fairly priced or undervalued.



As for the short term, Friday January 28th saw a robust market bounce after a very tumultuous week. While the bottom of this correction may have been seen at the lows made on Monday January 24th, we’ll only know that in hindsight in a few weeks. My best guess is that there may be one more re-test of that day’s low, but the real test right now is the robustness of the current bounce. If the recovery is solid and strong, then we may have seen the short-term lows for this correction.

Regardless, I don’t believe this means a straight up market and a full recovery of the immense damage done to tons of growth stocks, many of which won’t get back to old highs anytime soon, if ever.  If you’ve been nibbling on stocks into this decline, be ready to withstand a lot of back-and-forth action that will frustrate both the bulls (optimists) and bears (pessimists). “The secret to success in stocks is to not get scared out of them” – John Buckingham

If you’re stuck with poor performing investments, especially when you’re sitting on large losses, ask yourself whether it makes sense to sell them into the strength that any upcoming/current bounce ultimately provides. Don’t think that they’ll eventually and automatically come back, because many won’t. In general, I have a rule: if a long-term investment underperforms for 1-2 years after I buy it, it’s time to consider cutting it. Don’t be too hard on yourself about it; just be ruthless in letting go of stocks that may have their best days behind them. Deploy the cash in better opportunities. If you found yourself too heavily invested coming into this decline, you may want to take advantage of the bounce to lighten up your exposure and take some risk off the table. Disclaimer: This is in no way investment advice or a recommendation to buy or sell any securities; please consult with your financial adviser (or us) for help.

For our client portfolios, we remain invested along with our portfolio hedges, which we adjust to changing market conditions. In addition, by using options to dampen volatility, reduce overall risk and generate income, we are well positioned to profit from whatever the year decides to throw at us.

For 2022, I believe that after 21 months of unusually calm and one way upward markets, this year will prove to be a more “normal” year with two-way market action, and likely single digit positive returns. But my crystal ball is still broken, so take this forecast for what it’s worth.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Year-End Tax & Financial Planning Strategies for 2021

As we wrap up 2021, it’s important to take a closer look at your tax and financial plans. This year likely brought challenges and disruptions that significantly impacted your personal and financial situation –– a continued global pandemic, several significant natural disasters, new tax laws, and political shifts. Now is the time to take a closer look at your current financial and tax strategies to make sure they are still meeting your needs, as well as take any last-minute steps that could save you money.

We’re here to help you take a fresh look at the health of your tax and financial well-being, so here’s an overview of some opportunities to consider as we approach year-end.

Key tax considerations from recent tax legislation

Many tax provisions were implemented under the American Rescue Plan Act that was enacted in March 2021. This act aimed to help individuals and businesses deal with the COVID-19 pandemic and its ongoing economic disruption. Also, some tax provisions were passed late in December 2020 which will equally impact this upcoming filing season. Below is a summary of the highlights in recent tax law changes to help you plan.

Economic impact payments (EIPs)

The American Rescue Plan Act created a new round of EIPs that were sent to qualifying individuals. As with last year’s stimulus payments, the EIPs were set up as advance payments of a recovery rebate tax credit. If you qualified for EIPs, you should have received these payments already. However, if the IRS owes you more, this additional amount will be captured and claimed on your 2021 income tax return.

If you received an EIP as an advance payment, you should receive a letter from the IRS. Keep this for record-keeping purposes to help you determine any potential adjustment at tax time. Be sure to give this letter to your tax preparer.

Child tax credit

As part of the American Rescue Plan Act, there were many important changes to the child tax credit, such as:

  • The amount has increased for certain taxpayers (from $2,000 per child to $3,000-$3,600 depending on the child’s age)
  • It is fully refundable (meaning that taxpayers will receive a refund of the credit even if they don’t owe the IRS any taxes)
  • It may be partially received in monthly payments (which should have started in July 2021)
  • Is applicable to children age 17 and younger in 2021

The IRS began paying half of the credit in advance monthly payments beginning in July. Some taxpayers chose to opt out of the advance payments, and some may have complexities that require additional analysis. We’ll be here to help you navigate any questions to make sure that you get the most benefit for your family.

Charitable contribution deductions

Individuals who do not itemize their deductions can take a deduction of up to $300 ($600 for joint filers). Such contributions must be made in cash and made to qualified organizations. Taxpayers who itemize can continue to deduct qualifying donations. In addition, taxpayers can claim a charitable deduction of up to 100% of their adjusted gross income (AGI) in 2021 (up from 60%). There are many tax planning strategies in this area we can discuss with you, such as donating appreciated securities, which gets you a deduction for full fair market value while avoiding recognition of capital gain income on the securities donated.

Another one of those strategies, for those who are quite charitably inclined and regularly give $1,000 or more per year in cash donations to qualified charities, you may want to consider a donor-advised fund, especially if the total of all your other itemized deductions are close to or just around your standard deduction amount. Making a contribution to a donor-advised fund allows you to deduct your full contribution to the fund while making grants to various charities over any number of years in the future. Bunching these contributions into one year can make a big difference in your tax bill.

Required minimum distributions (RMDs)

RMDs are the minimum amount you must annually withdraw from your retirement accounts (e.g., 401(k), 403(b) or IRA) if you meet certain criteria. For 2021, you must take a distribution if you are age 72 by the end of the year (or age 70½ if you reached that age before Jan. 1, 2020). Planning ahead to determine the tax consequences of RMDs is important, especially for those who are in their first year of RMDs. If you’re currently a client, we have already addressed these for 2021.

Unemployment compensation

Another thing to note that’s different in 2021 is the treatment of unemployment compensation. There is no exclusion from income. The $10,200 income tax exclusion that a taxpayer may have received in 2020 is no longer available in 2021. We can help you plan for any potential impacts of this change.

State tax obligations related to teleworking arrangements

The pandemic has spawned changes in how people work, and more people are permanently working from home (i.e., teleworking). Such remote working arrangements could potentially have tax implications that should be considered by you and your employer.

Virtual currency/cryptocurrency

Virtual currency transactions are becoming more common. There are many different types of virtual currencies, such as Bitcoin, Ethereum, and non-fungible tokens (NFTs). The sale or exchange of virtual currencies, the use of such currencies to pay for goods or services, or holding such currencies as an investment, generally have tax impacts. We can help you understand those consequences, especially since most crypto brokers won’t be sending you a 1099 form for 2021.

Additional tax and retirement planning considerations

We recommend that you review your retirement situation at least annually. That includes making the most of tax-advantaged retirement saving options, such as traditional IRAs, Roth IRAs, and company retirement plans. It’s also advisable to take advantage of health savings accounts (HSAs) that can help you reduce your taxes and save for your future. If you’re self-employed, setting up a self-employed retirement plan may have to happen before the calendar year turns to 2022. We can help you determine whether you’re on target to reach your retirement goals or help you set up a company (or solo) retirement plan.

Tax Loss Harvesting

With another good year for the markets, you may have realized and cashed in some significant capital gains in taxable accounts. To help offset these realized gains, engaging in capital loss harvesting, at year-end, involves selling taxable investments that are currently showing an unrealized loss, in order to “harvest” that loss to offset the gains. You can deduct total losses equal to your current net capital gain plus $3,000 to offset other ordinary income (e.g., salary, pensions, social security IRA distributions, etc.). Keep in mind that investments sold at a loss (or substantially similar ones) cannot be repurchased for at least 31 days or the tax “wash sale” rules apply to suspend the loss realized (and you can’t repurchase the same securities in your IRA or 401(k) either for at least 31 days).

Other Ideas

Here are a few more tax and financial planning items to discuss with us:

  • Let us (or your planner) know about any major changes in your life such as marriages or divorces, births or deaths in the family, job or employment changes, starting a business or significant expenditures (real estate purchases, college tuition payments, etc.).
  • Make sure you’re appropriately planning for estate and gift tax purposes. There is an annual exclusion for gifts ($15,000 per donee, $30,000 for married couples) to help save on potential future estate taxes and avoid the need to file gift tax returns.
  • Consider Section 529 college savings plans to help save for education; there can be federal and potentially state income tax benefits to do so, and we can help you with any questions.
  • Consider any updates needed to insurance policies or beneficiary designations.
  • Evaluate the tax consequences of converting part or all of traditional IRAs to Roth IRAs.
  • Review withholding and estimated tax payments and assess any liquidity needs.

Looming potential tax legislation

With potential tax changes looming as Congress debates proposals in President Biden’s “Build Back Better” agenda, there remains uncertainty in how this will impact taxpayers. As legislation continues to evolve, and if it passes, we’ll communicate to you how changes impact your tax and financial plan.

Some provisions are retroactive to January 1, 2021, and may have a material effect on the final 2021 (and future) tax years.

The most significant provision, which affects most clients, is the potential increase in the state and local tax itemized deduction, currently limited to $10,000 per year. If an increase to this limit is enacted (very likely), it will allow for at least a maximum of $20,000-$40,000 deduction for state and local taxes. For this reason, if you have any state or local income or property taxes that can be paid in either 2021 or 2022, please wait as long as possible to pay them, pending legislation passage and additional guidance that we will communicate soon after the passage of 2021 tax legislation.

Year-end planning equals fewer surprises

There are many other opportunities to discuss as year-end approaches. And, many times, there may be strategies such as deferral or acceleration of income, prepayment or deferral of expenses, etc., that can help you save taxes and strengthen your financial position.

Fraudulent activity remains a significant threat

Our firm takes data security seriously and we think you should as well. Fraudsters continue to refine their techniques and tax identity theft remains a significant concern. Beware if you:  

  • Receive a notice or letter from the IRS regarding a tax return, tax bill or income that doesn’t apply to you
  • Get an unsolicited email or another form of communication asking for your bank account number, other financial details or personal information
  • Receive a robocall insisting you must call back and settle your tax bill

Make sure you’re taking steps to keep your personal financial information safe. Let us know if you have questions or concerns about how to go about this.  

If you would like to review your current investment portfolio or discuss any year-end financial or tax planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

‘Tis the Season to Be Thinking about Charitable Giving

With the holiday season upon us and the end of the year approaching, we pause to give thanks for our blessings and the people in our lives. It is also a time when charitable giving often comes to mind. The tax benefits associated with charitable giving could potentially enhance your ability to give and should be considered as part of your year-end tax planning.

Tax deduction for charitable gifts

If you itemize deductions on your federal income tax return, you can generally deduct your gifts to qualified charities. This may also help potentially increase your gift.

Example(s): Assume you want to make a charitable gift of $1,000. One way to potentially enhance the  gift is to increase it by the amount of any income taxes you save with the charitable deduction for the gift. At a 24% tax rate, you might be able to give $1,316 to charity [$1,000 ÷ (1 – 24%) = $1,316; $1,316 x 24% = $316 taxes saved]. On the other hand, at a 32% tax rate, you might be able to give $1,471 to charity [$1,000 ÷ (1 – 32%) = $1,471; $1,471 x 32% = $471 taxes saved].

However, keep in mind that the amount of your deduction may be limited to certain percentages of your adjusted gross income (AGI). For example, your deduction for gifts of cash to public charities is generally limited to 60% of your AGI for the year, and other gifts to charity are typically limited to 30% or 20% of your AGI. Charitable deductions that exceed the AGI limits may generally be carried over and deducted over the next five years, subject to the income percentage limits in those years.

For 99% of the population, this limitation is never a problem.

Nonetheless, for 2021 charitable gifts, the normal rules have been enhanced: The limit is increased to 100% of AGI for direct cash gifts to public charities. And even if you don’t itemize deductions, you can receive a $300 charitable deduction ($600 for joint returns) for direct cash gifts to public charities (in addition to the standard deduction).

Make sure to retain proper substantiation of your charitable contribution. In order to claim a charitable deduction for any contribution of cash, a check, or other monetary gift, you must maintain a record of such contributions through a bank record (such as a cancelled check, a bank or credit union statement, or a credit-card statement) or a written communication (such as a receipt or letter) from the charity showing the name of the charity, the date of the contribution, and the amount of the contribution. If you claim a charitable deduction for any contribution of $250 or more, you must substantiate the contribution with a contemporaneous written acknowledgment of the contribution from the charity. A copy of a canceled check is no longer enough to substantiate your deduction. If you make any non-cash contributions, there are additional requirements.

Year-end tax planning

When making charitable gifts at the end of a year, you should consider them as part of your year-end tax planning. Typically, you have a certain amount of control over the timing of income and expenses. You generally want to time your recognition of income so that it will be taxed at the lowest rate possible, and time your deductible expenses so they can be claimed in years when you are in a higher tax bracket.

For example, if you expect to be in a higher tax bracket next year, it may make sense to wait and make the charitable contribution in January so that you can take the deduction next year when the deduction results in a greater tax benefit. Or you might shift the charitable contribution, along with other deductions, into a year when your itemized deductions would be greater than the standard deduction amount. And if the income percentage limits above are a concern in one year, you might consider ways to shift income into that year or shift deductions out of that year, so that a larger charitable deduction is available for that year. A tax professional can help you evaluate your individual tax situation.

If you want to “turbo-charge” your charitable deduction, consider donating appreciated securities (stocks, bonds, mutual funds, etc.) Not only do you get a deduction for full fair market value of the security, you also escape capital gain taxes on the appreciation you donated. If you want to donate securities that have gone down in value, it’s always better to sell them first, capture the capital loss, then donate the cash (there’s no inherent advantage in donating depreciated securities).

If you give more than $1,000 a year to charity, it may be time to consider a Donor Advised Fund (DAF). A DAF allows you to “bunch” your charitable deductions to allow you to itemize deductions when you might otherwise only qualify for the standard deduction. By funding the DAF with an amount large enough to put you over the standard deduction, you can make charitable “grants” over several years while getting a full deduction in the year that you fund the DAF. Keep in mind that money transferred into a DAF can never be removed, and the only beneficiaries of the DAF are qualified Section 501(c)(3) charities. You can set up a DAF with most major brokers at no cost, and some have no minimums. Talk to us if you’d like more information about setting one up.

A word of caution

Be sure to deal with recognized charities and be wary of charities with similar-sounding names. It is common for scam artists to impersonate charities using bogus websites, email, phone calls, social media, and in-person solicitations. Check out the charity on the IRS website, irs.gov, using the “Tax Exempt Organization Search” tool. And never send cash; contribute by check or credit card and be wary of those asking for cash donations, unless perhaps they’re standing in front of a red kettle.

If you would like to review your current investment portfolio or discuss charitable giving or any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Required Minimum Distributions Are Back in 2021

As we approach the end of 2021, now might be a good time to take a closer look at a few developments surrounding Required Minimum Distributions (RMDs).

What Are RMDs?

Once you reach age 72, you are required to take minimum distributions from your traditional IRAs and most employer-sponsored retirement plans. (RMDs are not required from an employer plan if you are still working at the company sponsoring the plan and you do not own more than 5% of the company.) You can always take more than the required amount if you choose.

The portion of an RMD representing earnings and tax-deductible contributions is taxed as ordinary income, unless the RMD is a qualified distribution from a Roth account. Failing to take the full amount of an RMD could result in a penalty tax of 50% of the difference.

Generally, RMDs must be taken by December 31 each year. You can delay your first RMD until April 1 following the year in which you reach RMD age; however, you will then need to take two RMDs in one year — the first by April 1 and the second by December 31. (If you reached age 72 in the first half of 2021, different rules apply; see below.)

You may want to weigh the decision to delay your first RMD carefully. Taking two distributions in one year might bump you into a higher income tax bracket for that year.

New RMD Age and a 2020 Waiver Add Complexity

The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 raised the minimum RMD age to 72 from 70½ beginning in 2020.  That means if you reached age 70½ before 2020, you are currently required to take minimum distributions.

However, there was a pandemic-related rule change in 2020 that might have affected some retirement savers who reached age 70½ in 2019. To help individuals manage financial challenges brought on by the pandemic, RMDs were waived in 2020, including any postponed from 2019. In other words, some taxpayers could have benefited from waiving both their 2019 and 2020 RMDs.

Anyone who took advantage of the 2020 waiver should note that RMDs have resumed in 2021 and need to be taken by December 31. The option to delay to April 1, 2022, applies only to first RMDs for those who have reached or will reach age 72 on or after July 1, 2021.

New Life Expectancy Tables

The IRS publishes tables in Publication 590-B that are used to help calculate RMDs. To determine the amount of a required distribution, you would divide your account balance as of December 31 of the previous year by the appropriate age-related factor in one of three available tables.

Recognizing that life expectancies have increased, the IRS has issued new tables designed to help investors stretch their retirement savings over a longer period of time. These new tables will take effect for RMDs beginning in 2022. Investors may be pleased to learn that calculations will typically result in lower annual RMD amounts and potentially lower income tax obligations as a result. The old tables still apply to 2021 distributions, even if they’re postponed until 2022.

If you are a current client of YDFS and you haven’t taken your RMD for 2021, we will be in touch over the next couple of weeks to discuss your options and requirements.

If you would like to review your current investment portfolio or have more questions about RMDs, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

It’s Employer Open Enrollment Season: Making Benefit Choices That Work for You

Open enrollment is the window of time when employers introduce changes to their benefit offerings for the upcoming plan year. If you’re employed, this is your once-a-year chance to make important decisions that will affect your healthcare choices and your finances. This is the critical time to, at a minimum, consider whether changes in your benefit options are needed.

Even if you are satisfied with your current health plan, it may no longer be the most cost-effective option. Before you make any benefit elections, take plenty of time to review the information provided by your employer. You should also consider how your life has changed over the last year and any plans or potential developments for 2022.

Decipher Your Health Plan Options

The details matter when it comes to selecting a suitable health plan. One of your options could be a better fit for you (or your family) and might even help reduce your overall health-care costs. But you will have to look beyond the monthly premiums. Policies with lower premiums tend to have more restrictions or higher out-of-pocket costs (such as copays, coinsurance, and deductibles) when you do seek care for a health issue.

To help you weigh the tradeoffs, below is a comparison of the five main types of health plans. It should also help demystify some of the terminology and acronyms used so often across the health insurance landscape.

  • Health maintenance organization (HMO). Coverage is limited to care from physicians, other medical providers, and facilities within the HMO network (except in an emergency). You choose a primary-care physician (PCP) who will decide whether to approve or deny any request for a referral to a specialist.
  • Point of service (POS) plan. Out-of-network care is available, but you will pay more than you would for in-network services. As with an HMO, you must have a referral from a PCP to see a specialist. POS premiums tend to be a little bit higher than HMO premiums.
  • Exclusive provider organization (EPO). Services are covered only if you use medical providers and facilities in the plan’s network, but you do not need a referral to see a specialist. Premiums are typically higher than an HMO, but lower than a PPO.
  • Preferred provider organization (PPO). You have the freedom to see any health providers you choose without a referral, but there are financial incentives to seek care from PPO physicians and hospitals (a larger percentage of the cost will be covered by the plan). A PPO usually has a higher premium than an HMO, EPO, or POS plan and often has a deductible.

A deductible is the amount you must pay before insurance payments kick in. Preventive care (such as annual visits and recommended screenings) is typically covered free of charge, regardless of whether the deductible has been met.

  • High-deductible health plan (HDHP). In return for significantly lower premiums, you’ll pay more out-of-pocket for medical services until you reach the annual deductible. HDHP deductibles start at $1,400 for an individual and $2,800 for family coverage in 2022, and can be much higher. Care will be less expensive if you use providers in the plan’s network, and your upfront cost could be reduced through the insurer’s negotiated rate.

An HDHP is designed to be paired with a health savings account (HSA), to which your employer may contribute funds toward the deductible. You can also elect to contribute to your HSA through pre-tax payroll deductions or make tax-deductible contributions directly to the HSA provider, up to the annual limit ($3,650 for an individual or $7,300 for family coverage in 2022, plus $1,000 for those 55+).

HSA funds, including any earnings if the account has an investment option, can be withdrawn free of federal income tax and penalties if the money is spent on qualified health-care expenses. (Some states do not follow federal tax rules on HSAs.) Unspent balances can be retained in the account indefinitely and used to pay future medical expenses, whether you are enrolled in an HDHP or not. If you change employers or retire, the funds can be rolled over to a new HSA.

Three Steps to a Sound Decision

Start by adding up your total expenses (premiums, copays, coinsurance, deductibles) under each plan offered by your employer, based on last year’s usage. Your employer’s benefit materials may include an online calculator to help you compare plans by taking factors such as your chronic health conditions and regular medications into account.

If you are married, you may need to coordinate two sets of workplace benefits. Many companies apply a surcharge to encourage a worker’s spouse to use other available coverage, so look at the costs and benefits of having both of you on the same plan versus individual coverage from each employer. If you have children, compare what it would cost to cover them under each spouse’s plan.

Before enrolling in a plan, check to see if your preferred health-care providers are included in the network.

Tame Taxes with a Flexible Spending Account

If you elect to open an employer-provided health and/or dependent-care flexible spending account (FSA), the money you contribute via payroll deduction is not subject to federal income and Social Security taxes (nor generally to state and local income taxes). Using these tax-free dollars to pay for health-care costs not covered by insurance or for dependent-care expenses could save you about 30% or more, depending on your tax bracket.

The federal limit for contributions to a health FSA was $2,750 in 2021 and should be similar for 2022. Some employers set lower limits. (The official limit has not been announced by the IRS). You can use the funds for a broad range of qualified medical, dental, and vision expenses.

With a dependent-care FSA, you can set aside up to $5,000 a year (per household) to cover eligible child-care costs for qualifying children age 12 or younger. The tax savings could help offset some of the costs paid for a nanny, babysitter, day care, preschool, or day camp, but only if the services are used so you (or a spouse) can work.

One drawback of health and dependent-care FSAs is that they are typically subject to the use-it-or-lose-it rule, which requires you to spend everything in your account by the end of the calendar year or risk losing the money. Some employers allow certain amounts (up to $550) to be carried over to the following plan year or offer a grace period up to 2½ months. Still, you must estimate your expenses in advance, and your predictions could turn out to be way off base.

Legislation passed during the pandemic allows workers to carry over any unused FSA funds from 2021 into 2022, as long as the employer opts into this temporary change. If you have leftover money in an FSA, you should consider your account balance and your employer’s carryover policies when deciding on your contribution election for 2022.

Take Advantage of Valuable Perks

A change in the tax code enacted at the end of 2020 made it possible for employers to offer student debt assistance as a tax-free employee benefit through 2025, spurring more companies to add it to their menu of benefit options. A 2021 survey found that 17% of employers now offer student debt assistance, and 31% are planning to do so in the future. Many employers target a student debt assistance benefit of $100 per month, which doesn’t sound like much, but it adds up.(1) For example, an employee with $31,000 in student loans who is paying them off over 10 years at a 6% interest rate would save about $3,000 in interest and get out of debt 2½ years faster.

Many employers provide access to voluntary benefits such as dental coverage, vision coverage, disability insurance, life insurance, and long-term care insurance. Even if your employer doesn’t contribute toward the premium cost, you may be able to pay premiums conveniently through payroll deduction. Your employer may also offer discounts on health-related products and services, such as fitness equipment or gym memberships, and other wellness incentives, like a monetary reward for completing a health assessment.

If you have an opportunity to change your life insurance, disability insurance or other perks, you may want to talk to us about how much coverage you need. Don’t miss this annual chance to review your coverage and possibly elect higher coverage.

If you would like to review your current investment portfolio or discuss employer benefit options and enrollment, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

(1) CNBC, September 28, 2021

Perhaps Your Last Chance before the Backdoor Closes

Among the many provisions in the multi-trillion-dollar legislative package being debated in Congress, is a provision that would eliminate a strategy that allows high-income investors to pursue tax-free retirement income: the so-called “back-door Roth IRA”. The next few months may present the last chance to take advantage of this opportunity.

Roth IRA Background

Since its introduction in 1997, the Roth IRA has become an attractive investment vehicle due to the potential to build a sizable, tax-free nest egg. Although contributions to a Roth IRA are not tax deductible, any earnings in the account grow tax-free as long as future distributions are qualified. A qualified distribution is one made after the Roth account has been held for five years and after the account holder reaches age 59½, becomes disabled, dies, or uses the funds for the purchase of a first home ($10,000 lifetime limit) or for qualified higher education expenses.

Unlike other retirement savings accounts, original owners of Roth IRAs are not subject to required minimum distributions at age 72 — another potentially tax-beneficial perk that makes Roth IRAs appealing in estate planning strategies (but beneficiaries are subject to distribution rules.)

However, as initially passed, the 1997 legislation rendered it impossible for high-income taxpayers to enjoy Roth IRAs. Individuals and married taxpayers whose income exceeded certain thresholds could neither contribute to a Roth IRA nor convert traditional IRA assets to a Roth IRA.

A Loophole Emerges

Nearly 10 years after the Roth’s introduction, the Tax Increase Prevention and Reconciliation Act of 2005 ushered in a change that relaxed the conversion rules beginning in 2010; that is, as of that year, the income limits for a Roth conversion were eliminated, which meant that anyone could convert traditional IRA assets to a Roth IRA (of course, a conversion results in a tax obligation on deductible contributions and earnings that have previously accrued in the traditional IRA.)

One perhaps unintended consequence of this change was the emergence of a new strategy that has been heavily utilized ever since: High-income individuals could make full, annual, nondeductible contributions to a traditional IRA and convert those contribution dollars to a Roth. If the account holders had no other IRAs (see note below) and the conversion was executed quickly enough so that no earnings were able to accrue, the transaction could potentially be a tax-free way for otherwise ineligible taxpayers to fund a Roth IRA. This move became known as the “back-door Roth IRA”.

Employees working for companies which had retirement plans that allowed post-tax contributions into their 401(k)’s, along with “in-service distributions”, could replicate the back-door strategy in a potentially much bigger way, which became known as the “mega-back-door Roth IRA”

Note: When calculating a tax obligation on a Roth conversion, investors have to aggregate all of their IRAs, including SEP and SIMPLE IRAs, before determining the amount. For example, say an investor has $100,000 in several different traditional IRAs, 80% of which is attributed to deductible contributions and earnings. If that investor chose to convert any traditional IRA assets — even recent after-tax contributions — to a Roth IRA, 80% of the converted funds would be taxable. This is known as the “pro-rata rule.”

Current Roth IRA Income Limits

For 2021, you can generally contribute up to $6,000 to an IRA (traditional, Roth, or a combination of both); $7,000 if you’ll be age 50 or older by December 31. However, your ability to make contributions to a Roth IRA is limited or eliminated if your modified adjusted gross income, or MAGI, falls within or exceeds the parameters shown below.

If your federal filing status is:Your 2021 Roth IRA contribution is reduced if your MAGI is:You can’t contribute to a Roth IRA for 2021 if your MAGI is:
Single or head of householdMore than $125,000 but less than $140,000$140,000 or more
Married filing jointly or qualifying widow(er)More than $198,000 but less than $208,000$208,000 or more
Married filing separatelyLess than $10,000$10,000 or more

Note that your contributions generally can’t exceed your earned income for the year (special rules apply to spousal Roth IRAs).

Now or Never … Maybe

While no one knows for sure what may come of the legislative debates, the current proposal would prohibit the conversion of nondeductible contributions from a traditional IRA (or 401(k)) after December 31, 2021. If you expect your MAGI to exceed this year’s thresholds and you’d like to fund a Roth IRA for 2021, the next few months may be your last chance to use the back-door strategy.

You can make 2021 IRA contributions up until April 15, 2022, but if the legislation is enacted, a Roth conversion involving nondeductible contributions would have to be executed by December 31, 2021.

Keep in mind that a separate five-year rule applies to the principal amount of each Roth IRA conversion you make, unless an exception applies.

In addition to eliminating the conversion of nondeductible contributions from traditional IRAs to Roth IRAs, the proposed legislation includes a similar prohibition on the conversion of after-tax 401(k) contributions (so-called mega-back-door Roth conversions), as well as other retirement-related provisions affecting those with large account balances ($10 million and higher) and high incomes (more than $400,000 for single taxpayers and more than $450,000 for joint filers).

Don’t wait until the last minute to make these contributions or conversions. Brokerage firms are extremely busy during the last half of December, and will be especially so if tax legislation is passed this year. Now is the time to be thinking about doing this if it fits within your financial plan.

If you would like to review your current investment portfolio or discuss your Roth IRA options, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

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